The Chinese developer Evergrande (OTC:EGRNY) had barely been heard of in western circles until a week ago when they hit the headlines for all the wrong reasons. A week before this, Evergrande issued a public statement, admitting it was facing "unprecedented difficulties" and hired restructuring consultants. They refuted claims of bankruptcy despite having debts of over $305bn.
The massive Asian real estate firm has a declining economic model. In layman's terms, they have taken deposits from investors yet have failed to deliver on well over a million properties and have spiraling borrowing costs. On top of that, property prices in China's primary locations are starting to fade.
Evergrande had a deadline at the end of last week to pay $83.5m in bond interest payments, yet this milestone has elapsed without payment being made. They now enter a 30 day "period of grace," failing which the real estate giant will default.
Across the globe, the "borrow to build" financial heap of Evergrande was the catalyst for a stark one-day stock sell-off across all major indexes. The Wall Street Journal reported:
"Local governments in China have been told to prepare for the economic and community ripple effects should Evergrande skip its payments and collapse. Chinese leaders are keen on containing any unraveling that may hurt housing prices, damage growing household wealth, and cost the communist country jobs."
This will lead to a risk-off stance across markets until more is known and the potential fallout understood. Every lesson learned from the Lehman Brothers collapse appears to have been ignored by "the too big to fail" banks in China.
The government has a big decision to make: bailout Evergrande, which represents a reward for reckless lending and generally poor financial management, or leave them to flounder and hold on tight for what could be a significant global collapse. Common sense dictates the latter is unfathomable.
Meanwhile, in the US, the well-documented debt ceiling expiry is fast approaching. The end of September marks D Day, and Congress is running short on time to raise the borrowing limit, having already extended for two years since 2019.
The Senate is expected to vote this week on raising the debt ceiling. On previous occasions, the vote has gone through without too much abrasion between parties. However, this time, the US has a deeply divided view and could be seen on preliminary numbers heading towards a stalemate.
If this is the case, the US defaults by the middle of October 2021. The fallout? Much bigger than Evergrande.
The yield on the 10-year Treasury had quite a spike last week to over 1.4%. For those with a basic understanding of arithmetic, that means if you want to invest in the US's debt, the government will give you 1.4% interest. Given the 5% inflation the US is experiencing, it yields a rather unhealthy -3.6% real interest rate.
The Fed cannot afford to let these interest rates go higher. In April, there was a possibility that some stealth yield curve control had taken place, which could explain the turnaround. However, it is also common knowledge that the US cannot afford the interest payments on its balance sheets, with the debt level increasing by $1m every 22 seconds.
So what is the answer? Biden's is to borrow more. Can a country become insolvent? Imagine an individual asking the bank for a loan with debt numbers as bad as the US. It's not like we could convince the bank that printing money is the answer either.
The latest polls show Democrats have a majority of one in the upper chamber thanks to the vice president's vote in the event of a tie break. While Republicans oppose increasing the debt limit, the majority party on Capitol Hill will likely approve the hike using a parliamentary procedure.
Evergrande and the US are separate matters with potentially similar outcomes, all based upon the issuance of debt. The most likely results are the US will raise the debt ceiling, and the Chinese government will bail out Evergrande. Both are propped up with artificial money, and the solution to both situations is borrowing more money via printing machines.
With the US not far off negative $29 trillion, Biden wanting to add another 6 to that since taking power and a global level of over 300% debt to GDP, when this bubble bursts, and it will come at some point, it is going to be very, very ugly.